3 Monkeys and a Believer

Pass me a bottle, Mr. Jones

Believe in me

Help me believe in anything

I want to be someone who believes - Counting Crows, "Mr Jones"

The U.S. stock markets, in case you were out, are off to a screaming start in 2012. Led by most of the underperformers from last year (financials, industrials, materials), the markets launched themselves off the springboard of doom and gloom near the end of last year. Since December 28^th (when I wrote in Imitation May Be the Highest Form of Flattery, But This Time We'll Pass that I was buying a small basket of financials for a trade), the KBW Bank Index (BKX) is up over 16%, while the S&P 500 (SPX) is up just 8.0%. Since then I have written about how the markets were very tough to read – up significantly but with still room to run, although there were many cross-currents, so we were buying puts to hedge our downside and remain long. That was the right call in hindsight (which is always 20-20).

So now what? I want to believe this market will go higher (as a fund manager that is always long, it's a natural bias), but I have a hard time making a bull case after this move we have had. But until this week I was willing to go with the flow, as the path of least resistance was still up and the market was fighting the proverbial wall of worry (there were no believers in the "we can go higher" thesis). However, I am preparing to step aside and let the ride continue without me (again, I have to be long in my funds, but you don't at home). Why the change of heart?

Mr. Jones and me tell each other fairy tales

Stare at the beautiful women

"She's looking at you. Ah, no, no, she's looking at me."

Smiling in the bright lights

Coming through in stereo

When everybody loves you, you can never be lonely - Counting Crows, "Mr Jones"

The reason I'm having a change of heart is that now everybody loves the market. This week, the Three Monkeys (see no evil, hear no evil, speak no evil) have arrived and revealed themselves to the markets. In this incarnation, they are Larry Fink (the head of BlackRock (BLK), a great businessman and authority on bonds), Nouriel Roubini (a well-known perma-bear at Roubini Global Economics), and finally, the individual investor, via the weekly AAII Sentiment Survey. Paraphrasing for brevity, Fink said he'd be 100% in equities (versus bonds), Roubini capitulated and turned a bit bullish, and finally, the individual investor this week became extremely bullish, with the net AAII bullish reading at 31.4%. According to BTIG (www.BTIG.com), the reading has only approached 30 five times in the last 5 years, so it only happens about once a year, and 4 out of the 5 times it got close, the market dipped pretty hard (from 40 to 100 points on the SPX). Look at this chart from BTIG and you'll see why the AAII Sentiment Survey is the Third Monkey.

 

 

I will paint my picture

Paint myself in blue and red and black and gray

All of the beautiful colors are very very meaningful

Grey is my favorite color - Counting Crows, "Mr Jones"

So what do we do now? The markets rarely provide a black and white answer. Instead, the right path is usually colored in various shades of grey. If you own strong operating businesses that have been overlooked in this rally and are cheap, then you're "probably" ok holding on. For your more speculative plays, those of businesses you bought where the fundamentals are just "ok" but the stocks were priced for a great trade, it's getting very close to selling time (cough, ahem, hello Banks). For those that are more nimble and can trade, I'd be selling my longs into this rally, and teeing up some shorts. I'd be looking at SPY puts or an outright short. Your time horizon, as always, determines your path to your goal.

I received many good comments on the trading rules I posted in my last article Don't Confuse the Path with the Goal, so I am posting a few more here and will try to include some in each article from now on. This weeks are:

• There are two deep seated enemies in human nature – hope and fear. When a position goes against you, you hope that the next day it will be better, that it will be the last day that you lose money. When the hope turns to fear, you capitulate, ensuring a big loss. In contrast, when a position is working, you fear the profit will be lost the next day, so you sell --- too soon. To make money trading, you need to eliminate both emotions.
• The hope of making the stock market pay your bills is a prolific source of loss to traders. The stock market is not the fairy god-mother.
• It is as important to read yourself as it is to read the tape.

Don't be a Monkey. Stay disciplined, manage risk, and remove emotion.

S&P 500 (SPX) Support and Resistance Levels:

Support: 1346/1348, then 1344/1345, a little at 1340, then 1328/1330.

Resistance: still light at 1352/1355, then a lot of overhead at 1360.

Positions: None.